All power to the state! – money madness at the IMF

You cannot escape an all-pervasive sense of crisis these days. Impending doom does not only announce itself in actual events but also via the proliferation of ever more hair-raising schemes that claim to solve our problems. Maybe it should not surprise us if, at a time when the world’s most powerful central banks keep interest rates at zero for years on end and keep printing quantities of money that are simply outside the facilities of human imagination (trillions? quadrillions?), bravely hoping it will end differently this time, people get the impression that economics holds no certainties, that it is merely an exercise in limitless creativity. In his excellent speech to the New York Fed, Jim Grant reminded us that when the Financial Times first explained to their readers what QE was, back in 2009, one of those readers wrote in a letter to the editor: “I can now understand the term ‘quantitative easing, but . . . realize I can no longer understand the meaning of the word ‘money’.” – This gentleman is not alone. The basics of monetary economics have been tossed out the window and a merry ‘anything goes’ of policy proposals has descended on us. Otherwise sane-looking men and women now propose that, although years of zero interest rates have not solved our problems, everything will change once interest rates are negative. We should all get checks from the central bank with free money to spend, and government bonds at the central bank should be cancelled. Grown men dream of money from helicopters and money buried in bottles in the ground. “Whom the gods would destroy, they first make mad.”

Just when you thought it could not get any madder there comes a policy proposal that sets a new low in monetary policy discussion. Of course, in the current climate it is being hailed as ‘epic’ and ‘revolutionary’. The easily excitable Ambrose Evans-Pritchard, a tireless campaigner for man’s exploration of the unknown in the field of money, could not believe his eyes: “So there is a magic wand after all,” he writes in the Daily Telegraph, “one could eliminate the net public debt of the US at a stroke and, by implication, do the same for Britain, Germany, Italy or Japan.” It gets better all the time. No longer are we confined to debating arduous strategies for crawling slowly back to sustainable growth, no, we can now simply wipe out all our debt.

Harry Potter meets Irving Fisher

The proposal under discussion is the IMF’s Working Paper 12/202 by Jaromir Benes and Michael Kumhof (a link to a PDF version is provided in this article). It is titled “The Chicago Plan Revisited” and presents itself as a restatement of the ideas of Irving Fisher and Henry Simons of the University of Chicago from the 1930s and 40s, and an application of these ideas to the present crisis. It suggests the following:

‘Private money’ creation is the root of all economic evil. Most money today is created by ‘private’ banks through fractional-reserve banking. This means money-creation is linked to loan creation and debt accumulation. A hundred-percent reserve system is to be established by the state and the state will forthwith crack down on any attempt by the private sector to issue liquid financial instruments – near monies – that could be accepted by the public as cash equivalents. Money creation is put under the full control of the state. The new system is to be implemented right away in one big swoop: the banks are forced to borrow the needed reserves from the government (Treasury) to achieve the new 100 percent reserve ratios instantly. The government creates these reserves – as is usual in a fiat money system – out of thin air. In the US, this plan would amount to new reserves to the tune of 184 percent of GDP, according to Benes/Kumhof, which means $27.6 trillion or 15 times the combined size of QE1 and QE2. With the new 100% reserve requirement, this money will not circulate and not allow for further bank credit creation, which – it is expected by the authors – makes this intervention not inflationary. (A portion of the new reserves will also be cancelled in the next step.) The new reserves allow the government/central bank to ultimately transfer ownership of the bank assets to itself.

Importantly, these new reserves are issued in a process very different from how reserves are issued and placed with the banks today, for example through ‘quantitative easing’, and how it was suggested by Irving Fisher in 1935 (“100% Money”), or Milton Friedman in 1960 (“A Program for Monetary Stability”). These more ‘conventional’ procedures do not allow for any large-scale elimination of debt. Central banks acquire bank assets by exchanging them for newly created reserve money, which they issue as a claim against themselves (a liability), and under normal accounting principles, any write-down of the new assets (debt ‘forgiveness’) would necessarily cause the extinction of the bank reserves as well. Writing down debt shortens the balance sheet of the central bank and thus reduces the central bank’s liabilities, which are the banking system’s reserves.

Benes and Kumhof circumvent this by simply claiming that the new fiat reserves are not just a new liability of the central bank but that they are assets as well, Treasury Credit or ‘commonwealth equity’. Through this accounting gimmick, the state can issue new assets, simply as an administrative act. Thus, the new reserve money lengthens the balance sheets of BOTH central bank and ‘private’ banks in a first step, that is, the new reserve money is simultaneously an asset AND a liability for both. This novel approach then allows balance sheet reduction later on and debt forgiveness without elimination of the new reserves that now back bank deposits by 100%. (See model balance sheets on pages 64 to 66 of the Benes/Kumhof paper and compare them to the model balance sheet presented by Irving Fisher on page 57 of “100% Money”, 1935, which is much more conventional.)

At the end of this process, not only has a lot of debt disappeared, the separation of the ‘credit’ and the ‘money’ sphere of the economy is now total, and so is the state’s control over the monetary economy. This, Benes and Kumhof, make perfectly clear, is the ultimately goal of the exercise, and they claim it is to our benefit. Why? Here (very differently from Fisher and Friedman or, for that matter, any monetary theorist) they do not argue as economists, but quote anthropologists and certain monetary historians who claim that 1) money originated not spontaneously from direct exchange but is a creation of the state, or rather the state’s early precursors, such as priests and religious masters of ceremony; this is deemed important because the origin of money determines the “nature of money” (page 12) and therefore determines who should best control its issuance. 2) They argue that thousands of years of monetary history confirm that the state can be trusted fully with the monetary privilege. (If you remember history somewhat differently, then according to Benes and Kumhof you have to rethink. The paper follows a select group of maverick anthropologists and monetary activists that have simply rewritten monetary history. Needless to say, none of this was ever claimed by Irving Fisher or Milton Friedman, and to my knowledge, not even Henry Simons.)

Finally, the paper presents an elaborate econometric model that shows that all of this will work in reality.

In this essay I will do four things: I will put the proposed paper in the context of ‘Austrian ’ and Monetarist monetary theory, and show that it is not only outside these intellectual traditions but that its main argument is not even economic in nature. I will show that the core problem Benes and Kumhof claim to have identified is bogus, and that they do not understand money creation in our economy. I will then look at the paper’s peculiar historical, and non-economic, justification of complete state control of money, and show that this argumentation is highly dubious but also irrelevant. I will then show that the proposal presented relies on unprecedented forms of state intervention and crucially advances the notion that the state can create vast new assets – commonwealth equity – by decree, which allows it to claim to have no net debt and thus engage in loan acquisition and ‘debt forgiveness’.

What this paper is not: it is neither ‘Austrian’ nor Monetarist

Benes and Kumhof, early in their paper, claim that fractional-reserve banking increases the risk of bank runs, causes boom-bust cycles, and that a 100 percent reserve system would ensure greater stability. These observations are, in principle, correct. But this is, sadly, where it stops. Benes and Kumhof do not build on these insights. In fact, for their further argument these insights are completely irrelevant. Their paper does not bother to investigate the full range of effects of bank credit expansion, and ask, for example, if the expansion of base money by the central bank under a 100%-reserve system could not have similar or even the same adverse effects that deposit-money expansion has in a fractional-reserve system.

The Austrian School has provided the most comprehensive analysis of the effects of bank credit expansion and has shown most conclusively why more inelastic (‘harder’) monetary systems offer greater stability. Expanding the money supply always has disruptive effects as the inflow of new money must distort interest rates, and interest rates are crucial for the coordination of investment activity with voluntary saving. The question the ‘Austrians’ ask is not, who should control money creation, but should anybody control money creationShould anybody even create money on an ongoing basis? Once a commodity of reasonably inelastic supply, such as gold, is widely accepted as money, any quantity of this monetary asset – within reasonable limits – is sufficient, and indeed optimal, to satisfy any demand for money. Demand for money is demand for purchasing power in the form of money, and can always be met by allowing the market to adjust the price of the monetary asset relative to non-money goods. No money creation is needed, and any ongoing money creation is in fact disruptive.

‘Austrians’ tend to be critical of fractional-reserve banking but they are equally critical – in fact, even more critical – of fiat money and central banking. The problems they studied would also occur – and are even more likely to occur – if the fractional-reserve-banking system was replaced with one gigantic state central bank.

But Benes and Kumhof did not call their paper ‘The Austrian Plan Revisited’ but ‘The Chicago Plan Revisited’. The approach and the goals of the Chicago School were different. But it is still worth mentioning that in his 1935 book “100% Money” Irving Fisher suggested that his plan could be combined with the gold standard, something that is impossible with the Benes/Kumhof plan and that Benes and Kumhof show no interest in. Here is Fisher, page 16:

Furthermore, a return to the kind of gold standard we had prior to 1933 [before the domestic gold standard was abolished by Roosevelt and private gold confiscated, DS] could, if desired, be just as easily accomplished under the 100% system as now; in fact, under the 100% system, there would be a much better chance that the old-style gold standard, if restored, would operate as intended to operate.

This would indeed be the 100% gold standard that many ‘Austrians’ propose, and a system immeasurably more stable than what we have today. However, it was certainly not Fisher’s primary objective to restore the gold standard. Fisher wanted to maintain the fiat money system and consolidate the control of the central bank over the banking system by eliminating any remaining discretion by ‘private’ banks. Fisher was a big proponent of price index numbers. He believed the purchasing power of money could be measured accurately through statistics – a fallacy that is still widely believed today and still causes confusion and harm – and he was an early advocate of inflation-targeting. (For an Austrian School response to Fisher’s original plan see Ludwig von Mises, Human Action, 1949, Chapter XVII, 12. The Limitation on the Issuance of Fiduciary Media)

25 years later, Fisher’s fellow Chicagoan Milton Friedman also proposed a version of the 100% plan, this time with even less reference to boom-bust cycles or the potential for a gold standard. Friedman was an advocate of central banking because he believed that monetary and economic stability could be achieved by guaranteeing a stable, persistent and moderate expansion of the money supply, which is at the core of Friedman’s Monetarism. In a 100% system the state central bank – so he argued – can make sure that this would happen.

Importantly, both Fisher and Friedman had an asymmetrical view of monetary expansion. The ongoing expansion of the money supply – and therefore persistent injections of new money into the economy – were not considered harmful (quite to the contrary), as long as the money inflow remained moderate, but any contraction of the money supply (shrinking of bank balance sheets and destruction of money) was seen as a major problem and to be avoided at almost all cost. Their plans for full reserve banking was largely motivated by a desire to avoid the destruction of previously created deposit money. Of course, ‘Austrians’ see this very differently. The expansion of money – even if moderate and controlled – must already cause problems (capital misallocations), and when these problems come to the surface they cannot be suppressed with yet more money creation, at least not forever (although this is attempted under Friedman’s proposal for very easy monetary policy in crises).

It should now be clear why the Austrian School is enjoying a revival in the present crisis, not the Chicago School. Fisher and Friedman did not get their 100%- system with complete control over money creation for the central bank but whatever power central banks had in recent decades – and that power was formidable – was used in ways that were strongly influenced by the Chicago School. Fisher and Friedman have shaped modern central bank orthodoxy to this day. As long as inflation is moderate central bankers believe that no monetary problem exists, in line with Fisher. Even in the run-up to the present, spectacular financial crisis, inflation remained moderate in most major countries, at least in the common (and dangerously narrow) CPI definition. And for the past two decades, any crisis that, if left unchecked, could have caused bank balance sheet deleveraging and credit contractions was aggressively fought with low interest rates and base-money injections from the central bank, according to Friedman. In fact, the Bernanke Fed has repeatedly referred to Friedman’s policy descriptions as a blueprint for its own actions. However, none of this has prevented major financial imbalances to build, and these policies have even helped create these imbalances, as Austrian theory would suggest.

But I digress. None of this makes any impression on Benes and Kumhof. In fact, Benes and Kumhof seem decidedly uninterested in monetary theory, business cycle theory, or the Austrian School. There is no mention of Mises or Hayek, and only Carl Menger is mentioned – in a footnote and disapprovingly.

Instead, the paper sets up an entirely new and I believe bogus problem based on the premise that in our monetary system money is supposedly provided ‘privately’, that is, by ‘private’ banks, and ‘state-issued’ money only plays a minor role. From this rather confused observation, the paper derives its key allegation that ‘state-issued money’ ensures stability, while ‘privately-issued money’ leads to instability. This claim is not supported by economic theory and certainly not by anything in the Austrian School or, for that matter in Friedman’s Monetarism or Irving Fisher’s original plan. Monetary theory does not distinguish between ‘state-controlled money’ and ‘privately produced’ money, it is a nonsensical distinction for any monetary theorist. An attempt to give credence to this distinction and its alleged importance is made in a later chapter in the Benes/Kumhof paper but, tellingly, this attempt is not based on monetary theory but on an ambitious, if not to say bizarre, re-writing of the historical record.

Benes and Kumhof create an artificial problem

For any analysis of the present financial system a distinction between state-created money and privately created money is entirely artificial and of no help whatsoever, because in our system money is created in a process in which ‘private’ banks are intimately connected with the state central bank. Any distinction between ‘private’ and ‘state’ is thus arbitrary and for an analysis of the economic consequences of such a system meaningless. Yes, most money in circulation today is deposit money and sits on the balance sheets of nominally ‘private’ banks, but the reserves are state fiat money, only to be created by the state central bank, which the nominally private banks have to have an account with in order to receive a banking license. Fractional-reserve-banks rely crucially on state-sponsored and state-controlled central banks that have a lender-of-last-resort function and that can – in a fiat money system – create bank reserves at will, no cost, and without limit, and are, under normal circumstances willing to do so to backstop the banks. Without this crucial backstop fractional-reserve banking on the scale on which it has been practiced in recent years and decades would be inconceivable. In their description of the present system, Benes and Kumhof take no account of any of this. Frankly, they do not appear to understand it.

Here are two statements from the IMF paper that may at first appear sensible but that on closer inspection reveal the grave misunderstanding of our present system by Benes and Kumhof:

“In a financial system with little or no reserve backing for deposits, and with government-issued cash having a very small role relative to bank deposits, the creation of a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to supply deposits.” (page 5)

But what determines the willingness of the banks to supply deposits? Fractional-reserve banking (supplying deposits) is lucrative but also risky for the banks as the public can demand redemption of deposits in cash or in transfers to other banks, and banks cannot create cash or the reserve money required to facilitate transfers. These forms of money remain the prerogative of the state central bank. It is the certainty, or high probability, under present institutional arrangements that the central bank will support the banks and continue to supply whatever amount of cash and reserves is needed, that allows the banks to supply – very profitably, of course – vast amounts of deposit money on the basis of small reserve money. Should the public demand payment in cash, the central bank can reasonably be expected to stand by the banks and supply the needed cash.

In recent decades, the global banking system found itself on numerous occasions in a position in which it felt that it had taken on too much financial risk and that a deleveraging and a shrinking of its balance sheet was advisable. I would suggest that this was the case in 1987, 1992/3, 1998, 2001/2, and certainly 2007/8. Yet, on each of these occasions, the broader economic fallout from such a de-risking strategy was deemed unwanted or even unacceptable for political reasons, and the central banks offered ample new bank reserves at very low cost in order to discourage money contraction and encourage further money expansion, i.e. additional fractional-reserve banking. It is any wonder that banks continued to produce vast amounts of deposit money – profitably, of course? Can the result really be blamed on ‘private’ initiative?

Fractional-reserve banking on today’s scale requires two things: 1) a state-sponsored central bank that has the monopoly of bank reserve-provision and that has a lender-of-last resort function for the banking industry; 2) the central bank must have complete control over bank reserves and be able to create them at no cost and without limit. In short, the precondition for large-scale fractional-reserve banking is a complete, unrestricted fiat money system. By contrast, the ability of the central bank to create reserves is fundamentally restricted under a gold standard.

The gold standard was abolished and replaced with a system of entirely unconstrained state fiat money through an act of politics. The state established monopolistic central banks that have a lender-of-last-resort function for the banking sector. The state thus created the infrastructure that allows banks to supply vast amounts of deposits, and over the decades has repeatedly subsidized this activity and socialized its risks.

Here is the second statement by Benes and Kumhof:

“The control of credit growth would become much more straightforward because banks would no longer be able, as they are today, to generate their own funding, deposits, in the act of lending, an extraordinary privilege that is not enjoyed by any other type of business.” (page 5)

But what exactly constitutes the privilege? – In a free society, you are, of course, free to issue your own fiduciary media – just issue checks against yourself and have them circulate as money surrogates. You will probably have to convince the public that you will convert these checks into money proper on demand in order to persuade the public to use the checks as money equivalents, and even then you may not succeed. But if the public believes you and your endeavor is successful, you have indeed become a money-producer and can fund your own lending with your checks. In fact, this is pretty much how fractional-reserve-banking originated. So far no privilege. It only becomes a privileged business, and possible on the scale we see it today, once the state supports it. The ‘Austrian’ solution is straightforward: remove the privilege! Without fiat money, central banks and state-sponsored deposit insurance, let us see how much ‘private’ money creation there really is!

No theory but revisionist history

Benes and Kumhof try to argue in a separate part of the paper that the distinction between ‘privately produced’ money and ‘state-produced’ money is meaningful and important.  Here, they completely depart from any traditional analysis of money or even any that could still be called ‘economic’. An economic analysis of money understands money as a useful social institution and thus starts with an inquiry of what money is used for in general, including today by today’s money users (that includes you and me), and tries to explain, based on reasoning, what would therefore make for good money in a general context, including the present one. Benes and Kumhof, however, do not argue conceptually as economic theoreticians but as (re-)interpreters of history. History can tell us what is good money and how it comes about. The anthropologists and monetary historians Benes and Kumhof quote claim that because money originated – supposedly – with the state its issuance is best controlled by the state. Again, no economic – conceptual, logical, theoretical – explanation is given for why that should be the case and why this could be upheld as a general rule. Allegedly, history tells us that the state is a responsible issuer of money and the private sector an irresponsible one. And that’s that.

The interpretation of the historical record that is provided in support of this allegation ranges from the adventurous to the outright bizarre. Instances in which the redeemability of deposit money in gold and silver was abandoned by official decree and vast amounts of fiat money were created to fund wars, revolutions or other state expenditures, such as during the Revolutionary War in America, the Civil War in America, or 1920s Weimar Germany, are reinterpreted to show that the ensuing inflations and outright currency disasters cannot be blamed on the state but are entirely the result of the involvement of ‘private’ money issuers.

“Colonial paper monies issued by individual states were of the greatest economic advantage to the country…The Continental Currency issued during the revolutionary war was crucial for allowing the Continental Congress to finance the war effort. There was no over-issuance by the colonies,… The Greenbacks issued by Lincoln during the Civil War were again a crucial tool for financing the war effort, [Hooray! Another war courtesy of paper money! DS] … The one blemish on the record of government money issuance was deflationary rather than inflationary in nature.”

Really? – The ‘colonials’ that were issued to fund the war with Britain ended up worthless, and to this day there is the idiom “worthless as a continental” in the American language. The period of the Civil War, too, was one of unusually high inflation, and in 1879 the USA decided to go back on a gold standard, at which point a period of considerable growth and rising prosperity set in.

While the enthusiasm for paper-money-funded wars on the part of Benes and Kumhof is already a bit disturbing, what is particularly striking is that Benes and Kumhof, and the ‘historians’ they quote (in particular the activists David Graeber, an anthropologist and leading figure of the Occupy Wall Street movement, and Stephen Zarlenga, founder and director of the American Monetary Institute), try nothing short of a complete re-writing of economic history and suggest conclusions – not only in one instance but throughout ALL of monetary history – that not only fly in the face of the generally accepted historical record but also common sense. The state as a monopoly-issuer of money with no restriction whatsoever becomes a trusted guardian of the common weal – simply by being a state!

Their whole argument gets kooky in the extreme when they address more recent instances of fiat money currency disasters, for which we not only have ample documentation that supports the opposite interpretation but which some of the most distinguished monetary theorists actually lived through themselves and experienced first hand – and which they explained succinctly.

Ludwig von Mises wrote a seminal book on monetary theory in 1912 (Theories des Geldes und der Umlaufmittel), in which he laid the foundations for the Austrian Business Cycle Theory and in which he predicted (!) the European hyperinflations of the 1920s. He lived through the hyperinflation in Austria in 1923, and, as the chief economist of the Vienna Chamber of Commerce, was in direct contact with the key players in government and central bank. He later wrote his memoirs.

Benes and Kumhof now claim that all these accounts are simply wrong. The main culprit was not the state but the private sector. We only have to ask state officials (!) and they can tell us what really happened. Here is the IMF working paper, page 17:

“The Reichsbank president at the time, Hjalmar Schacht, put the record straight on the real causes of that episode in Schacht (1967).”

According to Benes/Kumhof, Schacht blames the inflation on aggressive money creation by the private sector but his account also suggests that this was only possible because the Reichsbank generously redeemed deposit money in Reichsmark, that is, the central bank provided essential support for money expansion. With a generous backstop from the state the private sector will, of course, create money. But does that mean the state had nothing to do with the whole debacle? Kumhof, Benes and their prime source, Zarlenga, seem to not understand the role of central banks and the essential ingredient of state-backing for large-scale fractional-reserve banking. Furthermore, Schacht is a source of a somewhat dubious reliability in this debate. Schacht became a Hitler supporter later on, introduced socialist New-Deal-type policies in Germany, and helped the Nazis with re-armament and plans for German autarky. I am not saying this to discredit Schacht as an economic observer, only to highlight that he had – and this is probably an understatement – a considerable pro-state bias in all his economic views and is hardly an objective observer on the question of whether the state can be trusted with money. (As an aside, all totalitarian ideologies are anti-gold and pro-paper money and central banks. The Socialists, the Communists, the National-Socialists, the Fascists – they all hated to see the state restrained in its manoeuvrability by a gold standard.)

Benes and Kumhof’s case simply ignores the numerous historical accounts that paint a very different picture, such as the work by English historian Adam Ferguson whose seminal book “When Money Dies” has recently found a wide new readership. It ignores the eye-witness reports of one of the most distinguished economists of the 20th century, Ludwig von Mises, or the work of Swiss monetary historian Peter Bernholz.

I am not a historian and I want to be careful in dismissing challenges to the established historical record out of hand, but the account presented here strikes me as simply ridiculous, unscientific, mystical pro-state propaganda. As a scientific argument it is without merit.

But almost the worst aspect of it is this: where are the economics, where is conceptual analysis and reasoning? Even if we accepted – simply for argument’s sake and contrary to the overwhelming evidence to the contrary – that the state has more often than not been a good guardian of the money privilege, what are the explanations for this, what are the theoretical and conceptual arguments that underpin this historical pattern? Could we rely on this always being the case? If it is in the “nature of money” (Benes/Kumhof) to be provided by the state, is it therefore in the “nature of the state” to always provide good money, or would we need specific institutional arrangements, legal frameworks, or some ‘good-money’-culture or tradition for this to be the case? Of course, Benes and Kumhof provide no answers.

This part of the paper is simply unscientific because the argument is essentially mystical. The whole idea that a socially useful institution such as money can only be understood if we understand its “nature”, which does not derive from how people use it (including you and me today) but from how it came into being thousands of years ago, is nothing if not rooted in mysticism.

Money is a tool, and so are hammers. If I asked you to tell me what a hammer is for, what makes for a good hammer and a bad hammer, and what type of hammer I need for a specific purpose, would you tell me that I first have to understand the “nature” of the hammer, and to do so I would have to ask anthropologists how the first hammers came into being and what the first hammers or hammer-like tools were used for?

Mystical assets

Remember what I said above about circulating your own checks as fiduciary media? That is a pretty good description of paper money issuance. The newly circulated paper money is accounted for as a liability on the balance sheet of the paper money creator, and the things he acquires through issuing/spending this new paper money become the corresponding assets. By issuing paper money the money creator lengthens his balance sheet, while those who transact with the money-creator neither lengthen nor shorten their balance sheets but exchange positions on the asset side of their balance sheets, they replace other, previously held assets with new money.

This can also be observed in the creation of base money (extra bank reserves) by central banks today. When the Federal Reserve creates an extra $1 trillion as part of ‘quantitative easing’ and decides to buy mortgage-backed securities from its member-banks, then the Fed’s balance sheet expands by $1 trillion dollars. The new bank reserves are on the liability-side of its balance sheet, while the mortgage-backed securities are on the asset-side. The balance sheets of the banks do not expand as a result of the Fed operation. The banks simply replace mortgages with new reserves. Both are on the asset side of their balance sheets. Their asset-mix has changed. They now have more reserves.

This process could be extended until almost all bank assets have moved to the central bank and the banks are fully reserved and thus cease to be fractional-reserve banks. This was precisely the process that Irving Fisher had in mind when he wrote “100% Money” in 1935 (see page 57), and Milton Friedman when he wrote “A Program For Monetary Stability” in 1960.

At no point did any of these economists suggest, nor does any central bank today suggest, that the creation of new paper money enhances the overall wealth of society, that there is now more property in this society. It is also clear from this process that ‘debt forgiveness’ by the central bank is difficult. The central bank can issue enough reserve money to acquire all bank assets but whenever it writes down the book value of any of these assets it also has to shrink the liability side of its balance sheet, it has to destroy reserve money.

Benes and Kumhof now come up with an entirely novel approach. The state simply declares that its new reserve money is also an asset in its own right. Per decree the state creates wealth: Treasury Credit or commonwealth equity. The central bank books the new reserves on its liability side, just as in a conventional money creation process but now does not book existing assets against it that it acquires from whoever books the new reserves as assets (the banks). The corresponding asset is now ‘Treasury Credit’, which did not exist before but now comes into being per government decree. At this stage, the central bank’s balance sheet lengthens without any acquisition of new assets – the offsetting asset is created simultaneously with the reserve money liability!

The balance sheets of the banks now also lengthen: the banks book the new reserves on their asset side without (at this stage) transferring other assets to the money-issuer. The asset-side of their balance sheets lengthens. The corresponding lengthening of the liability side is achieved by booking ‘Treasury Credit’ as a liability.

It is this slight-of-hand that allows, in the following steps, various bank assets to get written off without a corresponding shrinking of reserve money. Only via the accounting gimmick of creating central bank assets out of thin air (and not just new central bank liabilities) and thus claiming that overall wealth – new assets – have been created administratively by the government can the large-scale debt write-off that is the paper’s allegedly strongest selling point, proceed.

All of this is state intervention in private contracts and property rights on a gigantic scale. The state may have the power to rewrite accounting rules and simply claim the existence of mysterious ‘government wealth’. Stranger things were claimed by governments in the 20th century. But what are the consequences? How will the public react? What confidence will it have in the new 100% state controlled monetary system?

Simply writing off all household debt is a mixed blessing. How would you feel if you worked hard and saved and did pay down your debt to give your family financial security, only to find out that your irresponsible and reckless neighbors, living high on the hog on credit cards, just saw all their debt wiped out by the Benes/Kumhof plan?

All power to the state!

This whole plan is nonsense on the greatest scale. Benes and Kumhof have thoroughly embarrassed themselves. Maybe we should simply look the other way and ignore this ill-conceived rubbish, maybe excuse it as the confused musings of two state-worshipping econometricians who fell under the spell of the New Age historicism of Graeber and Zarlenga, which they saw as a great opportunity for some fancy econometric modeling. But this comes with endorsement from the IMF, a major state-organization. Could it be that those who benefit from the accumulation of more state power feel that all the widespread banker-bashing and the erroneous but skillfully planted notion of the failure of capitalism can be turned even more to their advantage? Even the otherwise intervention-happy Ambrose Evans-Pritchard has his doubts:

Arguably, it would smother freedom and enthrone a Leviathan state. It might be even more irksome in the long run than rule by bankers.

Ambrose, for once I agree.

In the meantime, the debasement of paper money continues.

This article was previously published at

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10 replies on “All power to the state! – money madness at the IMF”
  1. says: mrg

    Great article, Detlev.

    I’d be interested to hear your thoughts on the Baxendale-Huerta de Soto plan, which also promises to eliminate (government) debt in the transition to 100% reserve banking:

    Does it too resort to “the accounting gimmick of creating central bank assets out of thin air”.

    The plan always seemed too good to be true, but I was never able to put my finger on why.

  2. Congratulations for the first (that I know of) Austrian response to the Benes-Kumhof Research paper.
    I honestly hope that the dialogue is long, a little less rhetorical and, as you say, more scientific in its evolved form.
    I provide a link to Dr. Kumhof discussing his paper here as I heard him present separately at the AMI conference in September.

    Well, a lot is made of the fact that money created by the ‘state’ is considered the state’s “equity”, creating also an ‘asset’ on its books.
    While debt-based private money cannot really work that way, why can it not happen with government created and issued money?
    It’s the government’s money system.
    Do you know where those Greenbacks lie on the balance sheet right now of the CB?

    And as to the ‘economics’ of all this – it is not very far off at all from Fisher’s 100 Percent Money proposals, modernized as to method, and expanded to deal with the very real debt-crisis caused by the present debt-based money system.
    I’m not saying it is th only way, or the correct way, but it could be better than the KEEE-RASH! that the Austrians might prefer.
    Friedman called Fisher the greatest economist of the last century.
    These are not originally Fisher’s ideas, having evolved through Simons and the Chicago School, as you say, but grounded really in the works of Nobelist (Chemistry) Dr. Frederick Soddy.
    An understanding of the science behind his ideas on money can be had through a read of his Cartesian Economics lectures and his book on: “The Role of Money”.

    Shall we?
    For the Money System Common

  3. While I disagree with Austrians on several issues, I agree with their anti-fractional reserve policy. I also agree with Deltev that the IMF paper is nonsense in that it involves, far as I can see, magically eliminating all private debts.

    Well that’s nice for those with multi-million pound houses and mortgages to match, isn’t it? As to the poorest, i.e. those with insufficient incomes to get themselves a mortgage at all, they don’t join in the bonanza. Crackers.

    Re eliminating government debt (mentioned by mrg above) this isn’t really a big deal. That is, the government / central bank machine can print money and buy back debt (or cease rolling it over) anytime: exactly what they’ve under the guise of QE. It’s not a big deal because there is not much difference between £X and a promise by government to pay you £X at some future date, which is what government debt is.

    Milton Friedman actually advocated a system under which the only liability issued by the government / central bank machine is money: i.e. the “machine” does not issue interest bearing liabilities, that is “debt”. See paragraph starting “Under the proposal…(p.250) here:

  4. says: Paul Marks

    An end to the credit bubbles of banks sounds wonderful – till one understands that the people behind this do not want the credit bubble to burst, and for lending to be from real savings (certainly not).

    What they want is for GOVERNMENT to produce lots of money (basically by printing it) and hand to the banks – to be lent out. As if Alan Greenspan did not encourage enough monetary expansion in his years of folly.

    Not lending from real savings – unless one pretends the government printing press is “savings”.

    This plan was actually tried – by General Peron in Argentina.

    In practice it was marked by endless inflation in Argentina and the decline of Argentina from a standard of living on a par with Canada to the Third World.

    Statism is still the central belief system in Argentina – and their anti inflation policy is to put anyone who tells the truth in prison.

    As for economic theory.

    The move to Irving Fisher was a key mistake – Frank Fetter was right and Fisher was wrong (about a lot of matters).

  5. says: Paul Marks

    For the benefit of Joe B. and friends….

    Irving Fisher was surprised by the bust of 1921 – and (learning nothing) he was surprised again by the bust of 1929.

    To a Fisherite (such as Milton Friedman) the “collapse of the money supply” is the problem – they never see that it is the credit-money expansion (the “boom”) that is the real problem.

    What to avoid the “crash”?

    Then prevent the monetary expansion.

    If you do not want to prevent the monetary expansion (i.e. do not want lending to be from real savings – and for government to not endlessly support and back up credit bubble expansions) then do not talk about the “crash”.

    For your antics will only delay it (and make it worse) – they will NOT prevent it.

    I repeat.

    Want to prevent the “bust” – then prevent the “boom”.

    Have economic development based on hard work and savings – not short cuts and magic tricks.

    1. Perhaps you missed the fine print in the IMF research paper or even Fisher’s 100 Percent Money, and even Friedman’s “Framework” proposal or his Program for Monetary Stability.
      All of them fund loans through savings.
      They do that after separating the banking function from the money-creation function presently residing with the banking monopoly. The power of the sovereign state to issue money is restored to its rightful owner.
      The people and not the banks.
      So, please do not confuse the issuance of money(state action) with the making of loans (bank action).

      All of them propose to end the debt-based, so-called credit-bubble economy.
      All of them propose to limit monetary expansion to that which enables economic growth-potential without inflation.
      They propose to end the “boom”.
      They propose to prevent the “bust”.

      Unfortunately, Austrians claim a focal point that involves using savings to make loans when the reality is to posit that only private ‘people-Corps’ can create money.

      We should be able to identify flaws in either the proposed model structure or the outcomes. Those look fine to me.

      BTW, Fisher never gave investment advice, took shortcuts or did magic tricks.
      And neither do I.

  6. says: Paul Marks

    Joe your effort to defend Irving Fisher does not work – he did not understand economics (as his comments even after the crash of 1929 show). Frank Fetter was the correct path for American economics – but the establishment elite choose another path (the wrong one).

    By the way – as a child (long, long ago – we are talking more than 30 years ago) I was actually IN FAVOUR of the government printing monetary base (litterally printing it) and handing it out to the banks to cover their credit expansion ON CONDITION THAT the banks did not create another credit bubble (i.e. that all future lending would be 100% from REAL SAVINGS).

    Of course the government (or Central Bank) should not LEND the banks money on this scale – as they would have no way to repay the money (other than to lend out the monetary base they have been given – thus starting another inverted pyramid of debt).

    However, any such government gift (and it would have to be a gift) would have to be conditional on the the monetary base then being FROZEN. To be fair, in some (not all) of his writings Milton Friedman actually says that the monetary base should be frozen. If the monetary base was frozen and 100% of all bank (and other) lending was covered by monetary base – then we could start a discussion (there would still be lots of problems).

    But you do NOT say the monetary base should be frozen do you Joe? Not even AFTER a last bailout orgy for the banks.

    What do you actually say?

    You say that the creation of money should be returned to “the people” – you mean the “the government” you say “the people” the way that socialist (both Marxist and National Socialist – and other typed of socialist do).

    The last thing you want is for people (buyers and sellers) to choose a commopdity as money and to trade with it.

    On the contrary you support GOVERNMENT (to say “the people” is just a lie) fiat money.

    And you do not want it frozen (or you would have said so) – you want the printing presses to roll.

    Just like General Peron – whose plan you support (as I have mentioned in many times in various threads and you have not dissented from it once).

    You are no good Joe.

    You are no good in terms of economics, and you are clearly no good in moral terms either.

    As I have said before…..

    Joe you have no business being on this site – which is for people who support honest money (i.e. commodity money – freely chosen by buyers and sellers) not government fiat money expansion. You should not be here – your only reason to be here is to act as a troll.

    1. pn(I hadn’t even read the second comment when I wrote this.)

      And there we have it.
      What has it taken so long – to call me a liar and a no-good and not moral, and to complain that I am a troll – whatever that is – and to say that I should be banned from this site.
      It’s about time.
      But, lacking any substance to the claims, where is the morality in your actions?
      I ask the question.

      I am not a socialist at all.
      I abhor what little I know about socialism.
      I am a free-enterprise advocate.
      But I don’t hate government.
      Almost, at times. But not quite.
      As a result, I look for solutions wherever they lie.
      It’s a pity for our conversation that you are so dogmatic and closed-minded.
      It’s just a pity.
      That’s all it is.
      Are you any more than that?

      I thought this site disallowed ad-hominem attacks.
      It would be you to be banned.
      But look how much time we waste when we could be discussing things monetary.

      As to any substance of discussion, Fisher’s work in these monetary matters is well known and respected, and remains relevant today on its merits, which were, again, to gain Friedman’s praise as the greatest monetary economist of the last century.
      As to his post-crash writings, both his full-reserve banking proposals(1935, 1936) and his “Debt-deflation Theory of Great Depressions” stand out today as guidance for modern monetary economies attempting to overcome the debt-saturation of the entire global economy. Or, as you like to call it, the credit bubbles.

      It is for that reason the IMF authors respond to this present debt-crisis by re-drawing upon his work. Those are the monetary facts.
      But, of course, Fisher really picked upon the earlier work of Simons, etc, and all of them have a foundation of Frederick Soddy’s view of the modern monetary system.

      To all of us, the role of the government in a modern fiat monetary economy is that of creation, issuance and regulation of the nation’s money system, including the money supply. That is the role of all governments in monetarily sovereign states today.
      They have handled it miserably, we all agree.

      My statement that resort must be had to restoring the power of money to the people is what it says. If you’re not a ‘there’s a socialist behind every bush’ type, that is the power we the people obtained upon becoming sovereign at the resolution of our War for Independence – more distinctly, for monetary independence.
      Being sovereign decision makers about monetary matters, we the people got together and decided to give the money creation power to the government, under a legal system of checks and balances.
      The government in this country – the only one I’m speaking of when I say the government – has delegated its sovereign authority to create the nation’s money to the private banks.
      That was wrong and probably illegal.
      And we the people want it back.
      Because it was wrong.
      And we’re telling as much to our Congress.

      Actually I personally have no problem with alternative currencies.
      I believe alternative currencies can exist and provide a measure of diversity that also provides stability to the economy.
      But NOBODY can create the NATION’s money except the nation.
      Unless, of course, we DECIDE to change the system.
      Which any sovereign people can do.

  7. says: Paul Marks

    As usual my typing is vile. But my point is correct.

    We do not have time to waste on people like “Joe” – he is not going to be convinced and he is not a even a “freeze the monetary base – but first cover the bank credit with it” person. He is a “let the printing presses roll” person – just like General Peron (or the government of Argentina right now). I have given him plenty of chances to dissent from this (over months) – and he never has.

    Either this site really is for people who want “honest money” (i.e. commodity money freely choosen by buyers and sellers – not government fiat money expansion) or it is not.

    “Debate” is pointless with Keynesians as their OBJECTIVE is not the same as ours (indeed it is the opposite of ours). Debate is over how one achieves objectives – not over the objective itself, that is a matter of fundemental principles.

    Fundemental principles are not decided by debate.

  8. says: Paul Marks

    I have given Joe yet another chance to deny that he is a Peronist – to deny that he is a “let the printing presses roll” person(as with General Peron and his 100% GOVERNMENT FIAT MONEY reserves for the banks).

    And yet again Joe has failed to do so.

    Instead we get yet another lie – this time we get the GOVERNMENT called “the nation”, the standard totalitarian lie.

    It is obvious what Joe is – after all I have given him chance after chance (over months) to deny it, and he never has.

    Joe is a “let the printing presses roll” person – he believes in GOVERNMENT FIAT (whim) MONEY, and he does not even believe (like the late Milton Friedman) that this should be “frozen”. On the contrary like General Peron and the modern Peronists in charge of Argentina right now, Joe believes that the goverment (the GOVERNMENT not “the people” or “the nation” please let us stop with the absurd lies) should let the printing presses roll.

    Joe does not believe that investment should be financed by REAL SAVINGS – he believes that borrowing (both for investment and for consumption) should be financed by the GOVERNMENT PRINTING PRESS. Just as with General Peron or the modern government of Argentina.

    As I have said so many times – Joe has no business being on this site. He is an enemy of honest money (i.e money freely chosen by buyers and sellers) and a supporter of the absurd “effective demand” doctrine (violating Say’s Law) of “prosperity by printing press”.

    If I want to encounter someone like Joe all I need to do is to turn on a “mainstream media” television station (or whatever). Some places should be free of people like Joe – and a site dedicated to honest money and financing borrowing by REAL SAVINGS (not the printing press) should be one of them.

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